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2 I. FX Futures 1. Rationales: 1) To overcome Lack of Liquidity of Forward Market, which is mostly O.T.C. -> Futures Market has Standardized Transactions, and is Standing Market -> Futures are Common men’s Forward Contract 2) To overcome the Credit/Default Risk -> Third Party Market, Performance Bonds(Margin), etc. 3) Leverage -> Leverage in futures trading means that the amount you need to deposit is small in comparison to the amount of product it will control.

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7 6. Operation of Futures Market: Daily Reconstructed/Settled Forward market Margin Deposit (=performance bonds=Initial Deposit Requirement) Buy (take long-position) if you expect/need the price of a currency to rise; Sell (take short-position) if you expect/need it to fall. Futures settlement price changes every day Profits or Losses are settled on a daily basis from a mandatory margin account -> “Marking to Market”

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Numerical Example 1 For example, John buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10 contracts, his daily profit is $8,875. This is paid to him immediately. 8

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Suppose you buy a unit at 1.4444 $ per Sterling Pound ($/Pound; note that they use the direct quotation) Initial Margin Requirement by CME = $2,900 for a hedger Suppose Actual Initial Margin Deposited = $3000 Next day, the rate of GBP Futures falls to 1.4334 You have lost 11 points or 0.0110 dollar per Sterling Pound. - For one unit has 62,500 pounds. - You have lost 0.0110 dollar x 62,500 pounds Lost 687.5 dollars = Marking to the Market Your Margin Balance = 3000 – 687.5 = $ 2313.5 Maintenance Margin set by CME = $ 2900 You have to refill by the Variation Margin Requirement to refill = $ 587.5 10

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Numerical Example 2 You are a Canadian exporter to U.S. and are to receive U.S. 1 mil in 3 months, that is, June 2010(t+1). How would you do FX Hedging in the CME? 11

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To start: Performance bond = U.S. $ 3300 for a hedger Mindset: You have to put on the U.S. shoes-Act and think like you are a U.S. citizen for S U.S $./C$ What to do? You are (buying/selling) Canadian Dollar Futures (CD) in CME, which will expire/deliver on March 2010. How much? Each unit = C $100,000 So you buy 1/S = 1/0.82 =about 12 units of CD for $100,000 for the corresponding rate = 0.8159 at 10:25:30 AM CST 2/09/2009. Thus you pay 0.8159 x 100,000 x 12 = U.S. $ 978,900. You have to get it from Spot Market at the current Spot rate S t. 12